A drug-distribution pharmacy is a "qualified trade or business" for the small business stock gain exclusion, not a health-services business

Plain-English summary

Section 1202 lets investors exclude much or all of their gain when they sell "qualified small business stock" held more than five years, but only if the company is engaged in a "qualified trade or business." That excludes certain service fields, including health, and any business whose principal asset is the reputation or skill of its employees. Here a C corporation operated as a pharmacy that retails and distributes a limited number of drugs (under exclusive distribution arrangements), filling physician-ordered prescriptions and mailing them to patients. Its shareholders were negotiating to sell their stock, so the company asked the IRS to confirm it was in a qualified trade or business under § 1202(e)(3). The IRS agreed: the employees do not diagnose, treat, or manage patient care, patient contact is incidental to filling prescriptions, all revenue comes from selling drugs, and the company's principal asset is its exclusive distribution rights rather than any employee's reputation or skill. So the company is not in the "field of health" and is a qualified trade or business. The IRS did not rule on whether the other § 1202 conditions are met.

Ruling snapshot

• Question: Is a drug-distribution pharmacy a "qualified trade or business" under § 1202(e)(3), or is it barred as a health-services or reputation/skill business?
• Outcome: approved (ruled a qualified trade or business)
• Key authorities: IRC § 1202(e)(3); IRC § 1202(a), (c), (e)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202221006 Third Party Communication: None
Release Date: 5/27/2022 Date of Communication: Not Applicable
Index Number: 1202.00-00
Person To Contact:
------------------------ ----------------------, ID No. -------------
--------------------------- Telephone Number:
------------------------------ --------------------
----------------------------- Refer Reply To:
CC:ITA:B05
PLR-122237-21
Date: March 3, 2022

             TY: -------

LEGEND:

Taxpayer = -------------------------------------------------

Business = -----------------------------------------------------------------------------------------------------

Dear --------------:

This responds to a letter ruling request dated October 26, 2021, submitted on behalf of
Taxpayer. Taxpayer requests a letter ruling that it was engaged in a qualified trade or
business as defined in section 1202(e)(3) as of the date of the ruling request.

                                               FACTS

Taxpayer is organized as a C corporation and is a Business. Taxpayer is only involved
in the retail sale of a limited number of drugs and does not manufacture them. The
manufacturers of these drugs prefer entering into exclusive distribution arrangements
with companies such as Taxpayer.

Employees of Taxpayer include several pharmacists who fill prescriptions received from
physicians. Other employees coordinate the insurance coverage with respect to such
prescription orders. Once the insurance process is complete and the prescription is
filled by the pharmacist, Taxpayer mails the prescription to the patient’s home. The
non-pharmacist employees will also occasionally contact individuals receiving
prescriptions to inquire as to any side effects of the prescriptions and to schedule refills.
PLR-122237-21 2

Such non-pharmacist employees are not subject to state licensing requirements or
classified as healthcare professionals by any applicable state, Federal or regulatory
authority.

Pharmacists and other employees of Taxpayer have no contact or interaction with
physicians, other than to receive prescriptions from them. With respect to patients,
pharmacists interact with patients only if a patient has a question about a particular
prescription. Employees are never involved in diagnosing any medical issues or
recommending any treatment or drug to individuals. Their interaction with patients is
limited to the filling and maintenance of prescriptions as ordered by a physician.
Therefore, none of Taxpayer's employees diagnose, treat or manage any aspect of any
patient's care. Taxpayer's revenues are strictly related to the sale of such drugs, and
Taxpayer earns no revenues in connection with the medical care of patients.

Taxpayer represents that its shareholders are in the process of negotiating the sale of
their stock in Taxpayer to an unrelated third party.

                                       LAW

Section 1202(a)(1) provides that in the case of a taxpayer other than a corporation,
gross income does not include 50 percent of any gain from the sale or exchange
of qualified small business stock held for more than 5 years.

Section 1202(a)(3) provides that in the case of qualified small business stock acquired
after February 17, 2009, and on or before September 27, 2010, the exclusion is 75
percent.

Section 1202(a)(4) provides that in the case of qualified small business stock acquired
after September 27, 2010, the exclusion is 100 percent.

Section 1202(c)(2) provides that stock in a corporation is not treated as qualified small
business stock unless during substantially all of the taxpayer's holding period for such
stock, the corporation meets the active business requirements of subsection (e) and the
corporation is a C corporation.

Section 1202(e) provides that the active business requirements are met by a
corporation for any period if during such period at least 80 percent (by value) of the
assets of such corporation are used by such corporation in the active conduct of one or
more qualified trades or businesses, and such corporation is an eligible corporation.

Section 1202(e)(3)(A) provides that a qualified trade or business means any trade or
business other than a trade or business involving the performance of services in the
fields of health, law, engineering, architecture, accounting, actuarial science, performing
arts, consulting, athletics, financial services, brokerage services, or any trade or
PLR-122237-21 3

business where the principal asset of such trade or business is the reputation or skill of
one or more of its employee.

                                     ANALYSIS

Section 1202(e)(3) excludes businesses from being a qualified trade or business if they
offer value to customers primarily in the form of certain specified services, or in the form
of individual expertise. A question arises as to whether Taxpayer is (i) involved in the
performance of services in the field of health or (ii) where the principal asset of the trade
or business is the reputation or skill of one or more of its employees.

Taxpayer's employees are not engaged in the provision of medical services. Other than
the pharmacists, such employees are not certified healthcare providers and are not
otherwise regulated under state or Federal law. Taxpayer's pharmacists fill
prescriptions provided by health care professionals, and other employees help manage
the insurance process and occasionally communicate with patients regarding
prescription issues and timely refill requests. Any interaction with patients regarding
their prescriptions is merely incidental to ensuring receipt of their required prescriptions
or answering a patient’s question about them. Taxpayer’s employees do not provide
any diagnostic services or medical care to either patients or physicians, and all
revenues are generated by the sale of the drugs. Also, Taxpayer’s principal asset is
not the reputation or skill of one or more employees, but its exclusive pharmaceutical
distribution rights.

We conclude that for the purposes of section 1202(e)(3), Taxpayer is not in a trade or
business (i) involving the performance of services in the field of health or (ii) where
the principal asset of the trade or business is the reputation or skill of one or more of its
employees.

                                      RULING

Based upon our analysis of the facts as represented, we conclude that Taxpayer was
engaged in a qualified trade or business as defined in section 1202(e)(3) as of the date
of the ruling request.

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
appropriate parties. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, we express no opinion regarding whether conditions and
provisions specified in other subsections of section 1202 have been satisfied or are
applicable except as expressly provided herein.
PLR-122237-21 4

This ruling is directed only to the taxpayer requesting it and may not be relied upon by
shareholders of the taxpayer. Section 6110(k)(3) of the Code provides that it may not
be used or cited as precedent.

A copy of this ruling should be attached to Taxpayer's federal income tax returns for the
tax years affected. Alternatively, taxpayers filing returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of this ruling.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to your authorized representatives. We are also sending a copy of this letter
to the appropriate operating division director. Enclosed is a copy of the letter ruling
showing the deletions proposed to be made in the letter when it is disclosed under
section 6110 of the Code.

                                  Sincerely,



                                  Erika Reigle
                                  Senior Technician Reviewer, Branch 5
                                  Office of Associate Chief Counsel
                                  (Income Tax & Accounting)

cc: -------------------------